US buyers could be forgiven for wondering what on earth is going on with aluminum prices.
The LME quotation at $1,950 per metric ton for cash and not much more for 3-month delivery is deeply in the global cost curve for aluminum smelters, suggesting a market in dire oversupply — a position supported by nearly 4.9 million metric tons of stocks.
Yet the Midwest ingot price, the benchmark by which many contracts are indexed, is riding high at $0.9822/lb, or $2,165 per metric ton — some $200 over the LME cash price. The Midwest price has always traded at a premium over the LME, reflecting as it does the cost of delivery to the US Midwest from smelters based closer to the coast or warehouses in major metropolises, but $200 is way over the cost of delivery and reflects a market in crisis.
US consumers aren’t alone in facing such hefty premiums for physical delivery.
Japanese consumers have been paying $121-122 per metric ton premium in the second quarter, but as Andy Home writes in Reuters, third quarter premiums for Asia’s largest importer of aluminum (and the trendsetter for the region) has just been agreed at somewhere between $200 and $210 per metric ton, pretty much the same as US consumers face with the Midwest ingot price.
For the Japanese, this will be the highest-ever quarterly physical premium paid by buyers and represents a 70 percent jump over second quarter premiums. Japanese inventory is relatively high at 234,800 metric tons as of the end of April, so consumers’ willingness to pay such high premiums must be a reflection of a very tight physical supply market.
In Asia, the supply situation is exacerbated by the closure of Norsk Hydro’s 180,000-ton Kurri Kurri smelter and the potential closure of up to four other Australian smelters that must be facing similar cost pressures caused by a depressed local market; weak global metal prices; high power costs, and an uncompetitively strong Aussie dollar.
If Asia was alone, one could somehow understand the local supply constraints, but the reality is even recession-hit and debt-crisis-paralyzed Europe is paying similar premiums. Indeed, the cause of the problem can be seen by the massive queues of metal waiting to come out of LME warehouses: 872,700 tons at Vlissingen, 687,550 tons at Detroit and 96,650 tons at Johor, Malaysia. This metal is not destined for consumers, it’s merely being moved to capitalize on lower-cost rental deals in non-LME warehouses.
As the article states, in essence the effect of the stocks financing trade is to reduce dramatically the supply of accessible metal, forcing up the physical premium to a level symptomatic of a deficit rather than a surplus market.
At a $200-per-ton premium, a potential cap is being reached at which it becomes much less attractive to buy spot and sell forward; the forward LME market does not reflect the physical premiums being paid, effectively flattening the forward curve. But with low interest rates and an aversion to investments in shares or other “risky” assets, appetite for stock financing doesn’t look likely to dry up any time soon.
So although further rises beyond $200-per-ton premiums seem unlikely, a pronounced fall seems equally unlikely. Consumers are going to have to live with a high Midwest ingot premium over the LME for the time being.